Opinion: Foreign market swings indicate nervous investors

That’s the mantra of the nervous market and further evidence of the emotion that is driving way too many investors.

Yes, I said investors. Although the snap decision crowd usually consists primarily of traders and speculators, this time even some normally smart folks are tossing in the towel – regardless of the underlying fundamentals of their investments.

One area in which this has been patently obvious is the reaction of the foreign markets, as exemplified by the price swings of the exchange-traded funds that are based on foreign markets. Although foreign economies, whether emerging or developed, are growing at rates twice or more than the growth rate of the United States, and in spite of the fact that markets of those economies historically have had a limited correlation to our domestic markets, market prices overseas have fluctuated wildly but mostly in concert with U.S. markets. The noncorrelation advantage of foreign stock ownership, important to most investors using asset allocation, was brought into question during the wild gyrations of the markets during August.

Does that mean that a more direct correlation is here to stay? We doubt it and continue recommending that serious investors maintain at least a 20 percent portfolio representation among foreign issues. That is most easily obtained, with a high degree of diversification, by using ETFs.

Call it an anomaly or say that it’s just out of whack, but disconnects of this type have happened many times and present great buying opportunities. Don’t be discouraged; bear in mind that it can happen again, and take advantage of these opportunities when they pop up.

In a recent Rational Investing column, I wrote about “headline risk” that can cause market flips and flops, citing the subprime mortgage collapse. As the subprime fallout becomes ongoing news rather than headline news, the media will place less emphasis on it. But the ramifications of the subprime problem are going to be felt for several months. While the Federal Reserve has taken positive steps to address the problem, it takes time for any solutions to work their way through the difficulties, so be prepared to learn of more foreclosures and emotion-laced stories about folks losing their homes.

In the normal course of business, the housing problems would reflect the cyclicality of the industry and would be worked out within the system over a relatively reasonable period.

The big difference this time is not just the housing cycle but also the political cycle. Although we are more than a year away from the general elections, expect candidates from both parties to feel compelled to offer solutions to the problem. It defies logic to think that Washington can find a solution that doesn’t have unintended consequences but that is not likely to stop them. Whether protectionist trade barriers, farm subsidies for major corporations, universal health care, ethanol production requirements, the alternative minimum tax or other tax rates, or any other aspect of free markets with which they tamper, politicians have continually shown how uneducated they are in economics but how willing they are to pander.

In light of all this, what’s a person to do with his investments? Stay the course.

There’s nothing wrong with being cautious, so focus on fundamentally sound companies, especially those that pay dividends equal to or greater than the 10-year Treasury and that have a history of regularly increasing their dividends. Remember, earnings can be just about whatever the corporations’ accountants may make them, whereas dividends are real dollars you can put in your pocket. Corporations that pay regularly increasing dividends appreciate in value over time, as does any asset that regularly increases your income, whether it’s your business, rental properties, mineral or timber production, etc. And make certain that you have diversification outside the United States.

Clark Davis is a 37-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.